Tuesday, November 18, 2008

Another mind provoking post by Paul Krugman questioning what will take up the slack in the U.S. economy post-stimulus package. He first points to the components of GDP, specifically the increased role of consumption in the U.S. economy.

As Paul points out, the biggest changes in GDP by 2007 (as compared to the previous ~30 years) were the larger share of consumption and the growing negative trade deficit. Unfortunately as we've detailed, the consumer is struggling, but exports have provided a sliver lining.

Lets go to Paul for a guess into how this will play out:

Consumption probably isn’t going back to a 2007 share of GDP — savings are back. So what will fill the gap, once the stimulus is gone? Housing? Not for a long time. Business investment? Hard to see why. The natural thing would be to trade lower consumption for a smaller trade deficit.

But that’s going to be hard if the rest of the world is also in a slump, and in particular if emerging markets are facing currency crises.

What all this suggests — and it’s a very rough cut — is that our emergence from the era when massive fiscal stimulus is needed may hinge crucially on getting the world financial situation, not just our own, under control.